Secondary Marketshttp://www.mortgagenewsdaily.com/channels/secondary_markets/default.aspxSecondary Mortgage MarketsenCommunityServer 2008 SP2 (Build: 31106.96)Managing Pull-Through in a Volatile Rate Environmenthttp://www.mortgagenewsdaily.com/channels/secondary_markets/managing-pull-through-in-a-volatile-rate-environment.aspxThu, 14 Jun 2012 18:50:00 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:263332AQ0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=263332http://www.mortgagenewsdaily.com/channels/secondary_markets/managing-pull-through-in-a-volatile-rate-environment.aspx#comments<p>Benchmark TSYs and rate sheet influential TBAs are continuing their <b><a href="http://www.investopedia.com/terms/c/consolidation.asp#axzz1xiHi8V6X">consolidative
ways</a></b> today. &nbsp;</p>
<p>I describe this behavior as the market "<b>storing
energy</b>" --- energy that can be detrimental to pipeline hedges when released. It was after all the
release of stored energy that led production MBS coupons on their record
breaking run earlier this month. This is evident in the chart below... </p>
<p><img src="/cfs-file.ashx/__key/CommunityServer.Components.SiteFiles/146_2E00_/MBS_2D00_Secondary_2D00_1.png" /></p>
<p>Since setting new price highs on June 1<sup>st</sup>
&nbsp;we've whipped around a range that seems to be shrinking. Although we
haven't seen a breakdown in support levels, we're not getting &nbsp;sustained
positive progress either. &nbsp;One day prices go lower, the next they go
higher only to move lower the day after. Yet technical support continues to
hold. We're consolidating around a pivot. <b>It's like no one is willing to
commit to a rally or a selloff. It's like the market is waiting for guidance</b>
that either justifies the rally or confirms capitulation. &nbsp;&nbsp;</p>
<p><b>What's next?</b></p>
<p>Stored energy will be released and when it happens the move
will be intense. &nbsp;It's just a question of in what direction and when. If
you're looking to attach a directional bias to your breakout considerations,
remain focused on European bailout events (Greek elections on Sunday) and next
week's FOMC meeting (where QEIII hints will be discreetly disclosed). </p>
<p>Headline risk is huge. Batten down the hatches, get with
your processors, talk to your underwriters.</p>
<p><b>IT'S A GREAT TIME TO MICROMANAGE
YOUR PULL-THROUGH! <br /></b></p>
<p>Bill Berliner of Manhattan Capital Markets, the sponsor of this blog channel and pipeline hedging consultant, has provided deeper insight on the topic...</p>
<p>Managing pullthrough
is one of the most challenging aspects of a secondary manager's job.&nbsp; Traditionally, pullthrough has been managed
as an interest-rate option of sorts, which means that pullthrough rates are
highly correlated with mortgage rates.&nbsp;
Over the past five to seven years, however, credit-related factors have
increasingly determined whether or not loans ultimately fund.&nbsp; This has created a lock-in effect of sorts;
borrowers with pending applications are increasingly reluctant to let their
applications lapse.&nbsp; This is especially
true for applications that are progressing through lenders' pipelines.&nbsp; </p>
<p>This is not to say
that changing mortgage rates don't impact pullthrough rates-they clearly
do.&nbsp; However, the nature of the
sensitivity of pullthrough to mortgage rates changes as applications progress
through the credit process.&nbsp; This means
that pullthrough modeling involves calculating a pipeline's sensitivity to
interest rate changes, credit, and the timing of applications moving through
the various underwriting stages.</p>
<p>Correctly estimating
pullthrough rates is extremely important to the hedging effectiveness of lenders,
especially during periods of market volatility.&nbsp;
As an example, look at the below history of Fannie 3.5s
in early April.&nbsp; Over the course of six
trading days, prices fluctuated wildly between the low 102s and high 103s.&nbsp;<b> </b></p>
<p><b>A lender with a $100 million pipeline that used
a pullthrough rate 2% higher than their experience could have lost up to $30,000
on their position in a few business days.</b></p>
<p><img src="/cfs-file.ashx/__key/CommunityServer.Components.SiteFiles/146_2E00_/MBS_2D00_Secondary_2D00_2.png" /></p>
<p>&nbsp;</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/managing-pull-through-in-a-volatile-rate-environment.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/263332/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=263332" width="1" height="1">mbsmortgage banked securitiesNotes on the Current State of the Secondary Mortgage Markethttp://www.mortgagenewsdaily.com/channels/secondary_markets/06052012-current-state-of-the-secondary.aspxWed, 06 Jun 2012 18:31:38 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:261976Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=261976http://www.mortgagenewsdaily.com/channels/secondary_markets/06052012-current-state-of-the-secondary.aspx#comments<p>The impressive rally in the bond markets has pushed the 10-year yield to all-time lows, and MBS prices to record high levels. Front-month prices of Fannie 3.5s closed on 6/1 at 105-10, the same day that 10-year yields closed for the first time below the 1.50% level. However, the strength in bonds has served to obscure a number of details. The first is that the rally has been <b>concentrated in longer maturities.</b> Since May 1st, the yield on the 2-year Treasury has <b>barely budged,</b> pushing the 2-10 spread to its tightest level in years (as shown in Chart 1 below). The flattening of the curve has also impact the forward LIBOR rates; using Eurodollar futures, the forward LIBOR curve has also exhibited a noticeable flattening, as shown in Chart 2.<br /><br /><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.04.20.06/Chrt1_5F00_Curve1.gif" /></p>
<p><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.04.20.06/Chrt2_5F00_Euros.gif" /></p>
<p><br /><br />
There are a number of ways to interpret these developments. One is that the longer end of the curve (i.e., 7-years and longer) is the <b>only place</b> where there is room to move; at less than 0.70%, the 5-year has little room to move. It also suggests that investors expect the Fed to continue to buy longer-dated Treasuries even after the end of the Twist operation next month. This will be especially true if the Fed initiates another round of asset purchases in order to offset the risks of a renewed slowdown emanating from the European turmoil.<br /><br />
Despite the rally, &ldquo;<b>realized </b>volatility&rdquo; (or &ldquo;vol) is quite low. Bond traders generally watch both realized and so-called implied volatility. Realized vol represents a statistical measure of how volatile bond prices or yields have been over some defined period of time, while implied vols are market-implied numbers <b>derived </b>from an option&rsquo;s price. Chart 3 indicates that 60-day realized volatility on the 10-year is close to its lowest level since last summer. Despite the steady decline in rates since early April, yields had been inching downward at a steady rate, although the market became quite volatile last week (which was reflected in the uptick in the shorter 40-day lookback volatility). <br /><br />This is also reflected in implied volatilities on swaptions, which have also declined steadily throughout April and May and plunged last week. The <b>tame volatility</b> of the bond markets and the decline in implied vols both are <b>generally supportive</b> of MBS levels despite their stratospheric prices; since mortgages and MBS are implicitly short options, their prices tend to benefit from lower levels of volatility.<br /><br />
<img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.04.20.06/Chrt3_5F00_Realized_5F00_vol1.gif" /></p>
<p><br /><br />
It&rsquo;s worthwhile to revisit trading and discuss recent developments in 30-year 3s, an item of strong interest to lenders. I discussed the illiquidity and lack of sponsorship of Fannie 3s in a writeup a few weeks ago, prior to the latest downdraft in mortgage rates. With consumer rates trending below 3.80%, lenders now have an even <b>greater incentive to attempt to sell 30-year 3s.</b> It&rsquo;s interesting to note that the price behavior of Fannie 3s, as illustrated by the Fannie 3.5/3.0 swap, has recently exhibited better and more rational behavior. Chart 4 contains a scatterchart showing the Fannie 3.5/3.0 swap versus the level of 10-year Treasury yields.<br /><br /> The chart indicates that the pricing of Fannie 3s) has been much better behaved since mid-March than it was earlier in the year. The R-squared of the fitted values (basically a measure of how closely the fitted values represent the data points) is 0.42 for the entire period in question; since March 9th, however, the R-square is 0.84, implying a much closer fit and more predictable relationship between the swap and Treasury yields.<br /><br />
<img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.04.20.06/Chrt4_5F00_FN35_2D00_3swap1.gif" /><br /><br />
While I continue to believe that 30-year<b> 3s have no natural private buyer,</b> the Fed appears to be <b>filling the void</b> by buying roughly 100-200mm in Fannie 3s each week. (In the last report, the Fed bought $250mm FN 3s in July.) While small relative to the purchases of other coupons, Fed buying has been enough to create at least the appearance of reasonable liquidity in the coupon, and makes it a decent sale for mortgage bankers looking to hedge their pipeline of sub-4% 30-year conventional loans. It&rsquo;s also understood that the coupon will perform poorly in the event of a broad market selloff, which makes it a good sale in the current environment.<br /><br />
Originators need to <b>be cautious</b>, however, and aware of a number of potential <b>pitfalls</b>. At times, the coupon can seem to trade poorly, with fairly volatile price movements and very wide bid/ask spreads. For example, Treasuries opened sharply lower on Monday 5/21; early in the day, Fannie 3s had a quarter-point bid/ask spread before the market regained its footing. <br /><br />
Given its inherent illiquidity, originators using the coupon as a hedging vehicle should plan to assign loans to the trades; <b>expecting to pair these trades off could backfire</b> under a variety of circumstances. These could include a short squeeze, too many hedgers looking to pair out of trades at the same time, or the lack of sustained buying of the coupon by the Fed.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/06052012-current-state-of-the-secondary.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/261976/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=261976" width="1" height="1">Concerns Grow Over Freddie/Fannie Price Dislocationshttp://www.mortgagenewsdaily.com/channels/secondary_markets/05152012-fannie-freddie-price-dislocati.aspxWed, 16 May 2012 18:15:36 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:259253Bill Berliner1http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=259253http://www.mortgagenewsdaily.com/channels/secondary_markets/05152012-fannie-freddie-price-dislocati.aspx#comments<p>One of the themes discussed at the MBA&rsquo;s recent conference in New York was the idea of<b> &ldquo;a merger&rdquo; </b>of the mortgage-backed securities issued by Fannie Mae and Freddie Mac.&nbsp; The FHFA itself now lists one of its goals to "build a single securitization platform" in the <a href="http://www.mortgagenewsdaily.com/05152012_gse_conservatorship.asp">Strategic Plan for 2013-2017 this morning.</a>&nbsp; MBA President David Stevens recently addressed the concept, expressing concerns about the growing price and economic disparity between Fannie Mae and Freddie Mac securities.
<br /><br />Before continuing, it will be helpful to discuss the <b>differences between the Fannie and Freddie</b> securitization programs. Since it takes time for cash to be passed from servicers to the GSEs to and then to investors, both types of securities (as well as Ginnie Maes) pay investors after a &ldquo;delay.&rdquo; This is fairly simple in concept. All securities have a &ldquo;record day&rdquo; which determines who is the &ldquo;holder of record&rdquo; at any point in time. For agency MBS, the<b> record day </b>is always the 30th of the month. The actual cash (principal and interest) owed to the investor is then remitted to investors in the following month.</p>
<p> Fannie Mae always pays bondholders on the 25th day of the month following the <b>record date;</b> Freddie Golds pay on the 15th day of the following month. (Freddie Mac pools originally paid on the 15th day of the second month after the record date. In the late 80s/early 90s Freddie Mac created the Gold program, which moved the payment date up a month for fixed-rate pools; note that Freddie ARMs are still issued under the &ldquo;green&rdquo; program and have the old payment structure and delay.)
<br /><br />Because time has value, the shorter delay for Gold pools means that they<b> should </b>trade at a higher price than Fannies, assuming they are priced to the same yield and prepayment speed. At current levels, the constant-yield price of 30-year Gold 3.5s is roughly 2+ ticks higher than Fannie 3.5s. (The economic value of the delay difference is a function of a number of factors, including the pool&rsquo;s coupon and yield.)<br /><br />
Despite the shorter payment delay, however, Gold pools have almost always traded at a <b>concession to Fannies </b>rather than at a premium. The differential is largely due to the<b> liquidity</b> difference between the two agencies&rsquo; securities. According to the MBA, daily trading volumes for Fannie MBS are 20 times larger than those for Freddie Golds. The relatively impaired liquidity of Golds implies wider bid/ask spreads, making trading in the securities more expensive; it also means that prices are more apt to be impacted by heavy trading volumes and/or increases in market volatility. <br /><br />
As a result, it is significantly <b>more expensive</b> for investors and issuers to trade in Golds, meaning that they need to trade at a concession to Fannies in order to compensate for their reduced liquidity and higher trading costs. The price differential between the two programs is also growing, as illustrated by the following chart showing the pricing difference between Freddie Mac Gold and Fannie Mae 3.5s over the last few years. </p>
<p><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.04.20.06/51512-Berliner.gif" /><br /><br />The 60-day moving average of the concession has widened from 2-3 ticks in the fall of 2011 to its current level of 9-10 ticks; as of the close on Monday 5/14 the spread was 9/32s. Keep in mind that this shows only the <b>actual price difference</b>; the economic difference (i.e., including the delay difference) is roughly another 2+ ticks wider over time.<br /><br />
There is an <b>unfortunate circularity</b> to the price/liquidity issue. The lower prices paid for Gold securities means that originators pricing to Gold execution are at a significant <b>disadvantage </b>relative to those using Fannies as their benchmarks; in order to offer comparable rates, they must factor lower profit margins into their pricing. As a result, fewer originators create Gold securities, which results in reduced float for the securities, which serves to further impair liquidity.<br /><br />
Interestingly, Stevens&rsquo; comments included one questionable statement. He was quoted following the speech as saying &ldquo;&hellip;(A)nd the taxpayer subsidizes the lender for the difference between the two. Taxpayers will be saved hundreds of millions of dollars because the execution will no longer be subsidized." In the current market, with comparable g-fees for Fannie and Freddie, the cost of the price concession and inefficient execution is borne by the originators creating Freddie Mac pools.</p>
<p> However, without action to either <b>combine the securities</b> of Fannie and Freddie or somehow eliminate the price concession, the price and liquidity disparity is likely to grow worse, and issuance of Freddie pools will continue to shrink. The <b>true cost </b>to taxpayers will come in the future; over a longer horizon, it&rsquo;s easy to imagine that the government will be forced to continue supporting an increasingly uncompetitive enterprise.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/05152012-fannie-freddie-price-dislocati.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/259253/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=259253" width="1" height="1">Prospects For Liquidity in Conventional 3.0 MBS And Mortgage Rate Implicationshttp://www.mortgagenewsdaily.com/channels/secondary_markets/05022012-3-0-liquidity.aspxWed, 02 May 2012 18:12:21 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:257376Bill Berliner5http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=257376http://www.mortgagenewsdaily.com/channels/secondary_markets/05022012-3-0-liquidity.aspx#comments<p>At current near-record levels of <a href="http://www.mortgagenewsdaily.com/mortgage_rates/">consumer mortgage rates,</a> and with <a href="http://www.mortgagenewsdaily.com/mbs/">MBS prices</a> grinding higher, a natural question is whether rates are poised to push downward to new lows. In turn, <b>a critical issue is whether the market for 30-year conventional 3.0s has become liquid enough</b> to absorb a substantial increase in issuance of loans with rates of 3.75% and lower. I&rsquo;m dubious; as I&rsquo;ll show, the lack of issuance and thin float in 30-year Fannie and Gold 3s suggests to me that a sustained burst of issuance would crush its price and cause real difficulties for originators attempting to hedge their pipelines.</p>
<p>A brief review of pooling economics will be helpful at this point. <b> The key decision by originators for all loans is the coupon into which they can be originated (or &ldquo;slotted&rdquo;).</b> The decision is fairly straightforward. After accounting for the 25 basis points in required servicing that must be held, the execution question is whether to pool into the closest possible coupon or the coupon 50 basis points in rate lower. A key issue is how the guaranty fee is paid to the GSE in question. The question is whether optimal execution results from directing part of a loan&rsquo;s periodic interest payments toward paying the g-fee over the life of the loan or, alternatively, by paying the guaranty fee in the form of a single payment to the GSE (i.e., &ldquo;buying down&rdquo; the g-fee).<br /><br />
As an example, let&rsquo;s take a conventional loan with a 4.25% rate to the borrower. After accounting for the 25 basis points in required servicing that needs to be held (or sold), the originator has<b><span> two main <span>securitization</span> options:</span></b></p>
<p style="padding-left: 30px;">&bull; Pay the g-fee over time out of the loan&rsquo;s interest, hold/sell some excess servicing, and pool into a 3.5% pool; or<br />
&bull; Buy down the g-fee (by making a single payment to the agency) and pool into a 4% pool.
</p>
<p><span>The fee to be paid to the GSE for buying down the g-fee is in turn a function of two factors: the amount of the guaranty fee and the price (quoted as a multiple) that the GSE will pay for that cash flow. Combined with the notoriously expensive multiples quoted by the <span>GSEs</span> to buy down g-fees, </span><b>the increase in g-fees that went into effect in April makes it uneconomically expensive for originators to buy down g-fees. </b>This in turn means that originators now have a strong incentive to pool down (i.e., into lower coupons) when judging best-execution for their conventional loans.<br /><br />
This brings us to a discussion of Fannie and Gold 3s. <b>Originators would love to see robust and liquid trading in conventional 3.0s</b> so that they can clearly slot their 3.75% and lower loans into the coupon. However, I&rsquo;m not optimistic that the coupon is liquid enough to support even a modest burst of issuance. <b> Liquidity always has a chicken-and-egg element; </b><span>it&rsquo;s difficult to issue into an illiquid security, but liquidity can&rsquo;t improve without a significant amount of the security available to trade (i.e., a sufficient &ldquo;float&rdquo;). In this context, trading in conventional 3s remains problematic. Over the last six months, Fannie and Freddie have collectively issued 158.2 billion in 30-year 3.5s; over the same period, total issuance of 3s was 4.1 billion. The available float of the coupons paints a similar picture. While roughly 194.7 billion in 30-year 3.5s are available to trade (and relatively few have been locked up in agency <span>Remics</span>), total float in 3s in March was 4.2 billion.&nbsp; </span></p>
<p>(Read more on this relative lack of liquidity: <a href="http://www.mortgagenewsdaily.com/mortgage_rates/blog/245965.aspx">Time To Start Looking At 3.0 Coupons?</a>)<br /><br />
Of course, <b><span>all securities must go through this &ldquo;<span>liquification</span>&rdquo; process.</span></b><span> Two years ago, for example, total float in conventional 3.5s was only 1.4 billion; it only exceeded 100 billion in January of this year. What is different is the lack of natural buyers of 30-year 3.0s. The combination of their low coupon rates and long durations make them unappealing to banks and depositories, and they are very difficult to structure into <span>Remics</span>. (It&rsquo;s interesting to contrast them with 15-year 2.5s. The total float for conventional 2.5s is a more substantial 12 billion; moreover, there are natural buyers of the shorter-duration 15-year security, even though its coupon rate is quite low.)</span><br /><br />
As a result of these considerations, <b><span>I don&rsquo;t expect the liquidity in 30-year 3.0s to improve enough in the near future to make them a legitimate <span>securitization</span> coupon.</span></b> A pop in issuance would likely crush the coupon&rsquo;s price, and cause its day-to-day price performance to return to its erratic pattern seen earlier this year. This in turn will make it difficult for consumer mortgage rates to make a decisive push to new lows.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/05022012-3-0-liquidity.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/257376/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=257376" width="1" height="1">Loan Pricing, Pipeline Hedging, and MBS Coupon Swapshttp://www.mortgagenewsdaily.com/channels/secondary_markets/04262012-loan-pricing.aspxThu, 26 Apr 2012 18:57:45 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:256631Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=256631http://www.mortgagenewsdaily.com/channels/secondary_markets/04262012-loan-pricing.aspx#comments<p>&nbsp;</p>
<div>
<p>While servicing valuations and the various adjusters are the most obvious factors impacting loan execution and pricing, the price spread between different coupons in the same product (i.e., coupon swaps) also play important factors. &nbsp;We'll take a brief look at coupon swaps, and how they can impact pricing.</p>
<p>The reason that th<strong>e price differential is called a "swap" i</strong>s that it&nbsp;<strong>can be traded as a single transaction</strong>. &nbsp;In addition to quoting prices on different coupons, dealers will also quote bid and offer prices on the different swaps for coupons in 50 basis point increments. &nbsp;In trader-talk,&nbsp;<strong>to "buy" the swap is to buy the higher coupon and sell the lower coupon;</strong>&nbsp;the opposite transaction is considered "selling" the swap. &nbsp;(As with other transactions involving the relationship between multiple securities, whether you buy or sell the transaction depends on whether you gain or lose from an increase in the transaction's price.) &nbsp;The markets are&nbsp;<strong>quoted in the spread between the two securities;</strong>&nbsp;for example, the Fannie 4/3.5 swap can be quoted as 1 28/32s.</p>
<p>It's important to remember that the prices of different coupons do not move in lockstep. &nbsp;Broadly speaking, this is because the various coupons all have different durations, or sensitivity to changes in rates. &nbsp;In turn, the&nbsp;<strong>duration differences result from different expected prepayment rates.</strong>&nbsp;&nbsp;This is fairly straightforward. &nbsp;The loans backing the higher-coupon pools have higher note rates and therefore should experience faster prepayments; therefore, the durations of the different coupons (or "coupon stack") typically decline as the coupon increases.</p>
<p>For this reason, swap levels can never be looked at in a vacuum. &nbsp;For example, as of the end of trading on 4/23 the Fannie 4/3.5 swap was quoted at 1 28/32s (i.e, the price of FN 4s was 1 28/32s over the price of 3.5s). &nbsp;Over the last 60 days, the average level of the swap has been 1 31/32s. &nbsp;On that basis alone, you could conclude that the swap is 3/32s cheap to its recent history.</p>
<p>To correctly gauge the price level, however, the&nbsp;<strong>coupon swap has to be viewed in context of both time and the level of interest rates.&nbsp;</strong>&nbsp;The charts below shows scatter charts of the coupon swap on the vertical axis versus the yield of the 10-year Treasury on the horizontal axis. &nbsp;Chart 1 shows the price and rate histories over a long period of time (i.e., to December of 2010),</p>
<p dir="ltr"><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.00.21.04/bb1.gif" /></p>
<p dir="ltr">&nbsp;Chart 2 shows the same chart using a much shorter look-back period (to September 2011). &nbsp;The chart also shows linear regression lines generated through Excel; note that the most recent observation is marked with a red data point.</p>
<p dir="ltr"><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.00.21.04/bb2.gif" /></p>
<p><while></while></p>
<p>While traders are involved in these swaps all the time, originators don't generally pay much attention to them. &nbsp;This is probably a mistake. &nbsp;For example, if the swap is cheap but looks like it is moving back toward more normal levels, it may change the best-execution for some loans from the lower to the higher coupon. &nbsp;This in turn&nbsp;<strong>impacts how originators need to hedge their positions.</strong>&nbsp;&nbsp;For example, if the best-execution for a block of conventional loans with 4.25% note rates changes from FNCL 3.5s to 4s, the lender's position effectively lost a lot of duration; moreover, the lender may eventually have to swap its open commitment from 3.5s into 4s in order to deliver the loans.</p>
</div>
<p>&nbsp;</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/04262012-loan-pricing.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/256631/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=256631" width="1" height="1">Loan pricingTrading in MBS Pools Backed By HARP Loanshttp://www.mortgagenewsdaily.com/channels/secondary_markets/04182012-trading-pools-harp-loans.aspxWed, 18 Apr 2012 16:22:08 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:255414Bill Berliner1http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=255414http://www.mortgagenewsdaily.com/channels/secondary_markets/04182012-trading-pools-harp-loans.aspx#comments<p>Last week, I wrote about <a href="/channels/secondary_markets/04112012-prepay-speeds.aspx">specified pool trading</a> and how <b>originators need to take advantage of pay-up opportunities </b>by selling their production into the specified pool market. A separate but related subject is the market for pools backed by loans issued under the government programs designed to help underwater borrowers and stimulate the economy. While the general theme (i.e., the search for slower prepayment speeds) is the same, there are some differences in how the products are must be traded.<br /><br />Loans issued under the HARP program(s) by definition have high LTVs. (The programs specify that borrowers must have LTVs of at least 80% to qualify.) Technically, pools cannot be marketed as being backed by &ldquo;HARP loans,&rdquo; since neither Fannie nor Freddie release that information; as a proxy, pools are described as being backed by &ldquo;100% refi high-LTV loans.&rdquo;<br /><br />The market has developed various tiers to trade the higher LTV product, broken out by both LTV and TBA deliverability. Stratifications that are pooled under the standard product designations (i.e., FNCL and FGLMC, which are deliverable into TBA trades) and that trade at varying payups include pools backed by loans with LTVs of 80-90%, 90-95%, 95-100%, and 100-105%. The importance of deliverability stems from the fact that if the payups for the products disappear, the pools can still be sold into TBAs. This limits the risk that changing circumstances will cause investors to be stuck with illiquid and difficult-to-sell securities.<br /><br /><b>Pools backed by loans with LTVs higher than 105% are not deliverable into TBAs</b>, and thus cannot be placed in pools with FNCL or FGLMC designations. Loans with LTVs between 105-125% must be pooled under separate acronyms and traded as specified pools. Fannie currently only has the FNCQ program for 30-year loans, while Freddie Mac has the FGU program for 15- 20-, and 30-year loans; these are pooled as FGU4, FGU5, and FGU6 pools, respectively.<br /><br />These securities currently trade at <b>significant payups over TBAs</b>, particularly for higher coupons, because they have exhibited much slower prepayment speeds than generic MBS. Many investors will try to estimate the &ldquo;carry advantage&rdquo; of these securities versus TBAs, which can be estimated through the dollar roll market. For example, Fannie 4.5s are currently rolling at around 5/32s per month. (That means that if the current month is trading at 107-00, pools for the following month&rsquo;s settlement are trading at 106-27.) A roll calculator shows that 5/32s per month works out to be a financing cost of around 0.25% at a 533% PSA, the reported median speed for the coupon. If you run the security at a 0% PSA , the &ldquo;implied drop&rdquo; is now 10/32s. That means that very slow speeds are worth 4-5 ticks per month in carry; a point payup is therefore recouped in 7-8 months.<br /><br />The <b>newest specified pool categories have come from the HARP2 program</b>, which was designed to facilitate the refinancing of loans with LTVs higher than 125%. These loans are pooled under the FNCR designation for Fannie, and FGU9 for (30-year) Golds. These securities are somewhat different that the 105-125% LTV pools. In addition to not being deliverable into TBAs, these pools cannot be used as collateral in REMIC transactions. (This is because loans with such high LTVs are not &ldquo;eligible assets&rdquo; for REMIC transactions.) This suggests that the liquidity for these securities will be worse than for the FNCQ/FGU 105-125% elements, especially in a significant selloff where the coupon trades under par.<br /><br />However, <b>recent trades show that demand for the &gt;125% LTV pools is strong. </b>While the payups are behind those for FNCQ/FGU pools, the levels garnered in auctions for forward settlement were significantly through TBAs, and imply much better loan prices than those being paid by the GSEs&rsquo; cash windows. As with the 105-125% LTV securities, investors are paying for the expectation of very slow speeds; however, loans with very high LTVs are exhibiting almost no voluntary prepayments. Investors are apparently willing to accept the reduced liquidity of the securities and still pay through the TBA market for glacial prepayment speeds and the resulting boost in carry.<br /><br />A final note is that some observers look for some decent production of 15- and 20-year pools with LTVs greater than 125%. This is because the program creates significant pricing incentives for borrowers to shorten the terms of their loans. At this point, <b>only Freddie Mac has a designation for the shorter-maturity loans </b>(FGU 7 and FGU8 for 15- and 20-year loans, respectively), although Fannie Mae will probably follow suit in the next few months. &nbsp;</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/04182012-trading-pools-harp-loans.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/255414/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=255414" width="1" height="1">mbs tradingharpTargeting Slower Prepay Speeds With Specified Poolshttp://www.mortgagenewsdaily.com/channels/secondary_markets/04112012-prepay-speeds.aspxWed, 11 Apr 2012 14:48:34 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:254652Bill Berliner1http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=254652http://www.mortgagenewsdaily.com/channels/secondary_markets/04112012-prepay-speeds.aspx#comments<p>Last week's head-fake selloff and subsequent rally have
put MBS prices back in sight of their early-February (and all-time) highs.&nbsp; This in turn has forced investors to look for
ways to improve their investment results and carry-adjusted returns.&nbsp; Research over the last decade has
demonstrated that a number of attributes result in improved prepayment
performance-in a market where the weighted average dollar price is in the area
of 104, this means that investors want MBS with slower prepayment speeds.&nbsp; <b>This
can accrue to the benefit of forward-thinking originators </b>that can capture
at least some of these payups in their execution.</p>
<p>There are a number of
loan <b>attributes that tend to result in
slower prepayments</b> and/or reduced responsiveness to refinancing
incentives.&nbsp; The best-known attributes
are loans with smaller loan balances and impaired credit.&nbsp; Investors will pay significantly more than
TBA prices for pools backed by loans with these characteristics.&nbsp; As a result, the market for agency MBS has
created tiers in order to trade the variety of products being created; pools
backed by these loans trade as "specified pools" (or "spec pools") away from
the TBA market.&nbsp; </p>
<p>There are a <b>number
of reasons</b> <b>that</b> <b>smaller loans tend to prepay relatively
slowly</b>.&nbsp; Aside from the generally
lower incomes and financial strength of the borrowers, small loans have to
overcome significant hurdles in order to justify the fixed expenses involved
with refinancing.&nbsp;&nbsp; For example, a
borrower with a $230,000 loan can save about $67 a month by refinancing into a
loan with a 50 basis point lower rate.&nbsp;
If the total fixed costs of refinancing are $1,000, the borrower breaks
even in roughly 15 months.&nbsp; Borrowers
with an $85,000 loan, by contrast, would only reduced their P&amp;I payment by
$25/month, meaning that it would take over 3 years to recoup their expenses.</p>
<p>Other specified pool
buckets have formed around credit characteristics.&nbsp; <b>Loans
with weaker credit</b> (such as low FICO scores and/or high LTVs) have long
tended to pay relatively slowly, since these borrowers have difficulty in getting
new loans.&nbsp; (Their prepayment advantage
is even more pronounced in a tight-credit environment.)&nbsp; There are also specified pool cohorts for
characteristics such as <b>"brand new
loans."</b>&nbsp; Since borrowers tend not to
refinance their loans immediately upon closing, these pools also tend to prepay
very slowly for a number of months after issuance.&nbsp; Finally, there are other new programs (such
as MHA/HARP) that also trade at a premium to TBAs.</p>
<p>&nbsp;"Generic" MBS (i.e.,
loans without any definable prepayment advantage) are delivered directly into
TBAs.&nbsp; A variety of separate segments
have developed, most commonly by loan size.&nbsp;
The most commonly traded tiers are for loans with maximum pool balances
of $85K, $110K, $125K, $150K, and $175K.&nbsp;
The key element is that these pools define <b>the <i>maximum</i> loan balance in
the pool</b>, not the average.&nbsp; This
improves the performance of the pool by limiting the size dispersion within the
pool.&nbsp; </p>
<p>The different
segments are generally priced by coupon and attribute, and (at current prices)
are at <b>very strong levels</b>.&nbsp; Even some of the historically muted
prepayment stories, such as maximum-$150K conventionals, are trading extremely
well.</p>
<p><b>The key for
originators</b> is to monetize the incremental value of their spec pool
loans.&nbsp; While some correspondent lenders
will pay up for some loan attributes, most originators are forced to sell their
production at generic levels.&nbsp; In most
cases, selling loans in order to garner some of the market payups for the loans
means that originators need to have the authority to create their own pools and
hold the servicing for the loans.&nbsp;
Originators cannot maximize their revenues without taking advantage of
these payup opportunities.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/04112012-prepay-speeds.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/254652/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=254652" width="1" height="1">prepay speedsThe Non-Existent Non-Agency Market and Jumbo Lendinghttp://www.mortgagenewsdaily.com/channels/secondary_markets/03292012-jumbo-conduit.aspxFri, 30 Mar 2012 14:29:00 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:253077Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=253077http://www.mortgagenewsdaily.com/channels/secondary_markets/03292012-jumbo-conduit.aspx#comments<p>&nbsp;</p>
<p class="s5"><span>​</span><span class="s2">My interest was recently piqued by a report in National Mortgage News entitled &ldquo;Confidential Report: &nbsp;Jumbo Conduits Folding.&rdquo; &nbsp;The report stated that &ldquo;&hellip;&rsquo;several&rsquo; conduits formed over the past year have been shuttered, their investment capital returned to investors.&rdquo; &nbsp;While arcane developments in the MBS market may seem irrelevant to mortgage lenders, they have actually had a major impact on the markets, and will affect the lending business for years to come.</span></p>
<p class="s5"><span>​</span><span class="s2">In order to understand these developments, a brief primer on <b>non-agency MBS</b>&nbsp;</span><span class="s2">and its differences from</span><span class="s2">&nbsp;agency pooling practices will be helpful. &nbsp;In an agency pool, the credit support comes from the government agency in question, and is funded by paying a <b>guaranty fee</b> to the agency. &nbsp;(It&rsquo;s effectively an insurance policy with the premium being paid by diverting a portion of the loan&rsquo;s interest payment to the &ldquo;insurer.&rdquo;) &nbsp;By contrast, the typical non-agency (or &ldquo;private-label&rdquo;) structure <b>does not use insurance as the primary source of credit support, </b>either from the GSEs or from a private party. &nbsp;They instead use a technique called &ldquo;<b>subordination</b>.&rdquo; &nbsp;This means that the deal is<b>&nbsp;</b></span><span class="s2"><b>divided into separate&nbsp;</b></span><span class="s2"><b>sectors</b> that have<b> different priorities</b></span><span class="s2"><b>&nbsp;</b>with respect to receiving cash flows</span><span class="s2">&nbsp;from the loan collateral</span><span class="s2">. &nbsp;Generally speaking, the &ldquo;senior&rdquo; sector ha</span><span class="s2">s</span><span class="s2">&nbsp;priority for receiving principal and interest from the investment&nbsp;</span><span class="s2">entity</span><span class="s2">&nbsp;that holds the collateral; the &ldquo;subordinate&rdquo; sector receives cash once the seniors are paid.</span><span class="s2">&nbsp;&nbsp;(Note that private-label deal structures can be enormously complicated; this discussion is best treated as a simplified introduction.)</span></p>
<p class="s5"><span>​</span><span class="s2">The amount of subordination required for the senior class (or classes) is <b>determined by the rating agencies</b>, and this is an area that&rsquo;s created great difficulties in the market.&nbsp;</span><span class="s2">Both the amount of subordination and the price it&nbsp;</span><span class="s2">ultimately&nbsp;</span><span class="s2">garners are key factors in the overall execution of the deal; in turn, the execution determines the prices that can be paid for the loans that will collateralize the deal. &nbsp;(This is directly analogous to how agency-eligible loans are priced, except that the inputs are different.</span><span class="s2">) &nbsp;Historically, deals have been utilized in order to distribute lenders&rsquo; production</span><span class="s2">&nbsp;into the capital markets</span><span class="s2">; getting &ldquo;sale treatment&rdquo; for accounting purposes is important to lenders in order to prevent their balance sheets from ballooning.</span></p>
<p class="s6"><span class="s2">The rating agencies have been rightly singled out as culprits in the&nbsp;</span><span class="s2">2007-2008&nbsp;</span><span class="s2">mortgage&nbsp;</span><span class="s2">debacle</span><span class="s2">&nbsp;by<b> assigning unrealistically low subordination levels to deals</b>, which made the fundin</span><span class="s2">g of many types of dubious loans and&nbsp;</span><span class="s2">products economical. &nbsp;In the current market, however, the&nbsp;</span><span class="s2">rating agencies have made their models <b>unduly onerous</b>, to the point where <b>even high-quality loans are treated as&nbsp;</b></span><span class="s2"><b>very</b></span><span class="s2"><b>&nbsp;risky assets.</b> &nbsp;As a result, the amount of subordination required for deals to create triple-A senior tranches is&nbsp;</span><span class="s2">so large that non-agency securitization</span><span class="s2">&nbsp;is virtually uneconomical.</span><span class="s2">&nbsp;&nbsp;This is especially true for lo</span><span class="s2">ans with some credit blemishes. &nbsp;T</span><span class="s2">he subordination required for deals backed by&nbsp;</span><span class="s2">purchase&nbsp;</span><span class="s2">loans with</span><span class="s2">, for example, FICO scores between 720-740</span><span class="s2">&nbsp;</span><span class="s2">and</span><span class="s2">&nbsp;</span><span class="s2">LTVs</span><span class="s2">&nbsp;of 80%</span><span class="s2">, are so onerous that the deals are uneconomical to issue.</span></p>
<p class="s6"><span class="s2">This in turned has <b>directly impacted the business of lenders</b>. &nbsp;While published Jumbo loan rates are currently about 55-60 basis points over conforming rates,<b> these quotes are misleading</b>, since they are only for the very highest quality&nbsp;</span><span class="s2">&ldquo;super-prime&rdquo;&nbsp;</span><span class="s2">borrowers (with LTVs &lt;=70% and FICOs</span><span class="s2">&nbsp;of 760 or higher). &nbsp;Moreover, current jumbo rates (around the 4.60% area) are available only because banks are willing to hold high-quality jumbo loans on their balance sheets. &nbsp;<b>If they were pricing these super-prime loans based on securitized execution, rates would be at least 40</b></span><span class="s2"><b>&nbsp;basis points higher. </b>&nbsp;More ominously, the rates that fall out when running moderate-credit loans approach predatory levels, by legal standards. &nbsp;The only way&nbsp;</span><span class="s2">such&nbsp;</span><span class="s2">loans can be made at all is by non-depository originators that are willing to hold either the loans, or the deal&rsquo;s subordination, on their books. &nbsp;(Put differently, they are not concerned about getting &ldquo;sale treatment,&rdquo; and can treat the securitization as a form of long-term financing.)</span></p>
<p class="s6"><span class="s2">In my mind, this has <b>seriously impacted the mortgage and housing markets</b>, especially in high-cost states such as California. &nbsp;Rather than having a reasonably seamless transition between conforming- and jumbo-balance lending, the current lendin</span><span class="s2">g environment has broken down into multiple tiers, each with different rates structures and credit demands.</span></p>
<p>&nbsp;</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/03292012-jumbo-conduit.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/253077/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=253077" width="1" height="1">mbsSecondary Mortgage MarketExamining Some Effects of a Sell-Off on The Secondary Mortgage Markethttp://www.mortgagenewsdaily.com/channels/secondary_markets/03152012-secondary-market-selloff.aspxThu, 15 Mar 2012 18:30:00 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:251119Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=251119http://www.mortgagenewsdaily.com/channels/secondary_markets/03152012-secondary-market-selloff.aspx#comments<p>The Treasury market has sold off over the last few sessions with a
violence that brought the debacle of 1994 to mind for industry veterans.&nbsp; The yield on the 10-year has backed up by about
24 basis points since Monday&rsquo;s close.&nbsp;
What makes it feel even more wrenching was the fact that the market had
been trading in an increasingly tight range since October.&nbsp; The chart below shows the daily close of the
10-year (the black boxed line) versus bands that show 2 standard deviations of
price changes.&nbsp; Unlike last October&rsquo;s
selloff (which pushed the 10-year to 2.40%), this move pushed the 10-year yield
decisively beyond the upper 2SD band; this is a good graphic representation of
why this selloff <i>feels</i> so
cataclysmic.</p>
<p><img src="/cfs-file.ashx/__key/CommunityServer.Components.UserFiles/00.00.00.21.04/31512-BB-SDs.gif" /></p>
<p class="MsoNormal">(Here are some <a href="/mortgage_rates/blog/250974.aspx">additional charts of yesterday's pain from MND</a>)</p>
<p class="MsoNormal">&nbsp;</p>
<p class="MsoNormal">Mortgages had a tough
time toward the end of trading on Wednesday.&nbsp;
As rates rose and prices dropped over the last few days, the<b>
option-adjusted durations </b>(OADs) for 30- and 15-year passthroughs <b>extended
dramatically.&nbsp;</b> Using YieldBook&rsquo;s
calculations, the OADs for FN 3.5s and 4s both extended by 0.6-0.7; the OADs
for Ginnies extended slightly less.&nbsp; To
put this in context, the price of Fannie 3.5s would now be expected to change around
3/32s more for a 10-basis point change in yields than on Tuesday morning (holding
everything else constant, of course). </p>
<p class="MsoNormal">It&rsquo;s useful to consider some of the <b>technical factors</b>
impacting both the Treasury and MBS markets in this type of environment.&nbsp; The MBS <b>duration extension</b> discussed above triggers
the type of <b>convexity selling</b> I <a href="../../channels/secondary_markets/02122012-mbs-market-technicals.aspx">noted a few weeks ago</a>, in which investors
lighten their positions in order to shed duration.&nbsp; Unfortunately, this type of selling<b> tends to
feed on itself;</b> investors sell duration as their portfolios extend, which
pushes prices lower, which further extends durations, etc&hellip;In this way, the MBS
market&rsquo;s negative convexity impacts the overall market for fixed income by
exaggerating both selloffs and rallies.</p>
<p class="MsoNormal">Mortgage bankers also need to be aware of the<b> impact of
the selloff on execution.</b>&nbsp; A rule of
thumb is that production will tend to move to a higher coupon (i.e.,
originators will &ldquo;pool up&rdquo;) when the price of the current coupon moves below
102-16 for two months forward settlement.&nbsp;
(Right now, that would be FN 3.5s for May settlement.)&nbsp; We saw a <b>classic illustration </b>of this on
Wednesday.&nbsp; &nbsp;&nbsp;Early in the day, almost all originator
selling in Class A was seen in 3.5 coupons; and although 3.5&rsquo;s vastly
outnumbered 4.0&rsquo;s in terms of the daily total, &nbsp;by the end of trading, 4.0&rsquo;s were a noticeable
contributor.</p>
<p class="MsoNormal">This will impact the market in a variety of ways.&nbsp; The price performance of TBA 4s (both
conventionals and Ginnies) will probably<b> underperform their hedge ratios,</b> as
selling picks up and weighs on prices.&nbsp; Dollar
rolls are also <b>likely to richen,</b> since selling will tend to be in the back
months.&nbsp; Among other things, wider rolls
make it less attractive for lenders to hold their inventory of loans and
deliver them into a later-month TBA trade.</p>
<p class="MsoNormal">For secondary market managers, the key questions in this
type of market are related to <b>hedging decisions.</b>&nbsp; Assuming rates settle into the current area
(around 2.25% on the 10-year Treasury), I&rsquo;d be inclined to hedge my loans that
will be allocated into 4s using relatively long hedge ratios, given the
likelihood that originator selling pressures push their prices lower.&nbsp; Hedging loans that are pooled into 3.5s will
require a different strategy.&nbsp; I don&rsquo;t
recommend trying to buy convexity in the options markets, unless 1) you are an
experienced options trader, 2) you have extremely good analytical software, and
3) you&rsquo;re related to your trade counterparties.&nbsp;
<b>A better solution </b>is to very actively trade the hedge positions based on
market moves.&nbsp;&nbsp;&nbsp; While you don&rsquo;t want to
be <b>hyperactively </b>buying and selling, you can let your position get long as the
market trades higher (by not immediately hedging all new locks); in selloffs, however,
<b>immediately hedge new locks</b> using progressively longer hedge ratios.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/03152012-secondary-market-selloff.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/251119/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=251119" width="1" height="1">Secondary Mortgage MarketEffects of Cash Flows on Mortgage Servicinghttp://www.mortgagenewsdaily.com/channels/secondary_markets/03082012-interest-cash-flows.aspxThu, 08 Mar 2012 21:37:15 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:250316Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=250316http://www.mortgagenewsdaily.com/channels/secondary_markets/03082012-interest-cash-flows.aspx#comments<p>As capital market consultants, we spend a lot of time talking and thinking about servicing-what it is, how it is valued, and how it can be expected to behave.&nbsp; While a lot of people in the industry have an understanding of servicing and its related securities, I think it will be helpful to take a basic look at the concepts underlying<b> assets comprised entirely of interest cash flows</b>, as well as how that market evolved.<br /><br />Let's first take a look at mortgage cash flow streams. As we know, mortgage cash flows are comprised of principal and interest, both of which <b>behave quite differently</b>.&nbsp; The key point is that the amount of principal to be returned from an agency pool is fixed; prepayment speeds only influence when the cash is returned.&nbsp;&nbsp; However, <b>timing does impact the value</b> of the principal cash flows due to the time value of money.&nbsp; As a simple example, the principal component can be envisioned as a series of zero-coupon cash flows that an investor is scheduled to receive over time.&nbsp; If the timetable for the payment series is accelerated, the investor makes a windfall profit; alternatively, slowdown in the receipt of the cash hurts the investor's returns. &nbsp;</p>
<p>The interest component is <b>entirely different</b>.&nbsp; Unlike the principal cash flows,<b> slower prepayment speeds benefit the returns</b> on a pure interest cash flow, while faster speeds hurt its returns.&nbsp; This is because the amount of interest to be paid to investors is a <b>function of the amount of principal outstanding</b>, which in turn is dictated by prepayment speeds.&nbsp; (Think of the interest as a dividend thrown off by the business; if the business shrinks or disappears, so does the dividend.)<br /><br />To illustrate this difference, let's take a brand-new FN 4% pool with an original face value of $1mm.&nbsp; Changing the prepayment speed impacts the timing of the principal cash flows, which is reflected in the security's weighted average life or WAL.&nbsp; (The WAL is the weighted amount of time that the bond's principal is outstanding, given some prepayment assumption.)&nbsp; If a 0% PSA prepayment assumption is used (i.e., there will be no prepayments on the pool), the WAL is 18.3 years; the WAL declines to 8.95 using a 150% PSA assumption.&nbsp; However, in both cases the investor receives a total of $1mm in principal back.&nbsp; (Remember that this is an agency pool, so our favorite Uncle guarantees the principal.)&nbsp; However, the <b>total amount of interest paid varies greatly with the prepayment assumption</b>.&nbsp; At 0% PSA, the investor would receive <b>$732,500 in interest</b>; at 150% PSA the total interest received drops to <b>$356,486</b>.&nbsp; Therefore, prepayments impact both the timing and the amount of the interest cash flows paid to investors.<br /><br />Investors first tried to capitalize on the different behavior of mortgage principal and interest by creating securities that redistribute interest within the security (or, more accurately, a trust backed by MBS pools).&nbsp; The earliest "strips" were created by taking current-coupon pools (then 9%s) and then creating "discount" and "premium" securities with coupons of, say, 6% and 12%.&nbsp; These eventually evolved into so-called <b>principal-only (or PO)</b> and<b> interest-only (or IO)</b> securities.&nbsp; Markets for IOs and POs developed for a variety of reasons.&nbsp; Some investors that were looking to make <b>explicit bets on the direction of prepayment speeds</b> found either one or the other side to be attractive.&nbsp; In addition, some investors took advantage of the leveraged performance of the bonds to make explicit interest rate bets; finally, both POs and IOs can serve as hedging vehicles.&nbsp; (Also, investors looking to create synthetic discount or premium securities can re-combine IOs and POs from the same trust to create a variety of coupons.)<br /><br />Given the sensitivity of IOs and POs to varying prepayment rates and the fact that prepayment speeds are primarily influenced by interest and <a href="/mortgage_rates/">mortgage rates</a>, the <b>price behavior of IOs and POs are quite different</b>.&nbsp; POs tend to have durations that are greater than the underlying pools (or "collateral," using the industry terminology); the normal response of a bond to changing rate levels is amplified by the associated change in speeds.&nbsp; By contrast, IOs typically have negative durations, i.e., their prices rise as interest rates rise.&nbsp; <b>What's really happening</b> is that the normal price sensitivity of any cash flow based on changing interest rates or IRRs is offset, to varying degrees, by the fact that the composition and value of the cash flow is <b>strongly influenced by the underlying asset's prepayment speed</b>.&nbsp; (Note that IOs don't always have negative durations.&nbsp; IOs backed by loans that are very far out-of-the-money, for example, may have a flat or slightly positive duration; since changes in the prepayment speed of the collateral will probably be muted, the basic sensitivity of any cash flow to interest rate changes will predominate.)<br /><br />This leads to a discussion of the relationship between servicing assets and IOs.&nbsp; Excess servicing (i.e, the interest cash flows that falls out as part of the process of pooling) is, truly, an IO cash flow; excess servicing can (and has) been securitized into so-called excess-servicing IOs.&nbsp; Required (or "base") servicing, however, is significantly more complicated to value and hedge.&nbsp; For example, it costs more to service delinquent loans; as with non-agency securities, some estimation of future delinquencies and defaults must be made in order to accurately gauge the potential future costs of servicing a loan.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/03082012-interest-cash-flows.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/250316/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=250316" width="1" height="1">Examining Factors Affecting ARM Loan Pricinghttp://www.mortgagenewsdaily.com/channels/secondary_markets/02292012-arm-loan-pricing.aspxWed, 29 Feb 2012 21:12:12 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:249331Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=249331http://www.mortgagenewsdaily.com/channels/secondary_markets/02292012-arm-loan-pricing.aspx#comments<p>A topic of particular current interest is the <b>state of the ARM market</b>, particularly with respect to the factors that drive ARM lending rates. Despite the record-low levels of <a href="/mortgage_rates/">fixed mortgage rates</a>, the mortgage &ldquo;curve&rdquo; remains fairly steep; the national average for agency 5/1 ARM rates is around 2.80%, roughly 100 basis points lower than the 30-year conforming rate. Consumer ARM rates remain fairly volatile and unpredictable, especially when compared to fixed mortgage offerings. To understand this better requires a bit of background on the ARM sector. <br /><br />The <b>popularity of ARMs</b> has typically waxed and waned. ARMs had a burst of popularity in 2003, and remained en vogue until their poor credit performance gave the product a taint of disrespectability after the mortgage meltdown in 2007. ARM lending activity continues to be depressed; according to the MBA&rsquo;s most recent report, just over 5% of applications (by loan count) were taken as ARMs last week. What is interesting, however, is the likelihood that much of ARM issuance is in the jumbo sector; the MBA data also shows that the average size of an ARM loan application is $473K, over double the size of the average fixed-rate loan ($198K).<br /><br />At this time, virtually all jumbo ARM production winds up on the books of banks. In part, this is because there is currently no reliable securitization outlet for non-agency loans of any kind. However, banks and depositories are happy to hold high-quality ARM loans in their investment portfolios. Their relatively short durations means that they have less exposure to price fluctuations than fixed-rate loans; they also expose institutions to less risk of shifts in the yield curve. Lenders will often retain the loans they fund for their portfolios; there are also fairly active markets in whole-loan ARM packages, where originators sell their issuance of ARM loans (mostly jumbo loans, at this time) to banks and other depository institutions.<br /><br />One reality for lenders, however, is that many buyers are small- and mid-size banks whose appetites for the product can be sporadic. The intermittent nature of whole-loan ARM demand is reflected in the prices quoted by investors for ARM loans and, ultimately, in the offerings to borrowers. By contrast, most conforming-balance ARM loans are securitized in agency MBS pools. The agency ARM market is much less liquid than the fixed-rate market, however, even during periods where ARMs lending is popular. In the current environment, liquidity is further constrained by the lack of issuance and tradeable supply (or &ldquo;float&rdquo;). (One paradox of trading is that a lack of issuance results in illiquidity; illiquidity results in lower prices for the resulting securities; lower prices result in reduced issuance.) In addition, ARM liquidity is also impaired by the nature of the product. Unlike in the fixed-rate MBS market, there is no TBA market that allow for the forward trading of fungible obligations.&nbsp; The illiquidity of the ARM markets means that pricing for the securities tends to be sporadic and somewhat volatile, which in turn is reflected in correspondent loan pricing.<br /><br />Finally, ARM loan pricing is impacted by the <b>pricing of ARM servicing</b>. ARMs tend to experience very high rates of prepayment, with speeds peaking around the time that ARMs experience their first rate resets. The fast and irregular prepayment speeds exhibited by the product means that ARM servicing generally is valued at relatively low multiples. As with the pricing of the other components, weak servicing valuations are reflected in the prices offered by investors for ARM loans.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02292012-arm-loan-pricing.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/249331/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=249331" width="1" height="1">MBS Market Technical Factors: Dollar Rollshttp://www.mortgagenewsdaily.com/channels/secondary_markets/02232012-technical-factors-dollar-rolls.aspxFri, 24 Feb 2012 00:27:03 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:248622Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=248622http://www.mortgagenewsdaily.com/channels/secondary_markets/02232012-technical-factors-dollar-rolls.aspx#comments<p>Previously we discussed the technical factor <a href="../../channels/secondary_markets/02122012-mbs-market-technicals.aspx">convexity</a>.&nbsp;
Another set of technical factors that impact secondary managers are in
the dollar roll market that we discussed a few weeks ago. &nbsp;Dollar rolls
(i.e., the price difference between the same security for different
months&rsquo; delivery) are impacted by a number of factors. &nbsp;First consider
the different participants in the MBS markets. &nbsp;Originators are
generally selling their production for later months, given the factor
that rate locks are taken under the understanding that the loans will
fund at some point in the future. &nbsp;That means that there is systemic
selling pressure in the later (or &ldquo;back&rdquo;) months. &nbsp;</p>
<p>Alternatively, some investors (such as banks) want to <b>buy MBS for early settlement</b>,
since they can only begin to accrue coupon earnings once they own
settled securities. &nbsp;Finally, CMO desks (i.e., the units in
broker/dealers that structure and market agency CMOs) have a structural
need to buy various types of agency passthroughs for current-month
settlement in order to settle their deals. &nbsp;(That&rsquo;s why CMO traders
refer to passthrough pools as &ldquo;collateral;&rdquo; to them, they&rsquo;re just fodder
for deals.)</p>
<p>The combined impact of back-end selling and early-month demand means
that dollar roll levels are often rich (or &ldquo;special&rdquo;) to where they
should trade based on fundamental factors such as funding rates and
short-term prepayment speeds. &nbsp;The specialness of rolls is often
exacerbated during periods of heavy issuance of MBS and/or CMOs.
&nbsp;Investors that have the option of buying front- or back-month
settlement (such as money managers) can often take advantage of dollar
roll specials to effectively gain cheap financing for their MBS
holdings. &nbsp;(I&rsquo;ve had investors tell me that dollar-roll levels were the
single biggest factor in choosing what MBS coupons to hold.)</p>
<p>The other factor impacting rolls, which is important to secondary
managers, is the fact that rolls far out in settlement often trade
erratically. &nbsp;Broker screens often will show three delivery months,
i.e., the current month, plus the next two back months. &nbsp;That means that
up until notification day, the current month and the next two months
will be on the screen. &nbsp;For example, levels for February, March, and
April were shown as a delivery month until after last Thursday (2/9);
after that, February was removed and May was added. &nbsp;Prices for May then
moved roughly back in line with other months; April/May rolls went from
trading at around 14/32s to around 10/32s.</p>
<p>This means that secondary managers that sold TBAs for May settlement
simply because they had a lot of long-term locks in their pipelines
traded inefficiently. &nbsp;It would have been much better for them to have
continued to sell April TBAs until May actually were added to broker and
TradeWeb screens. &nbsp;At that point, they should look at their pipelines
and adjust their positions to account for their expected fundings for
each month. &nbsp; A healthy respect for the market&rsquo;s technical conditions
will often help lenders improve their hedging efficiency and secondary
results.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02232012-technical-factors-dollar-rolls.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/248622/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=248622" width="1" height="1">MBS Market Technical Factors: Explaining Duration and Convexityhttp://www.mortgagenewsdaily.com/channels/secondary_markets/02212012-duration-and-convexity.aspxFri, 24 Feb 2012 00:23:07 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:248246Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=248246http://www.mortgagenewsdaily.com/channels/secondary_markets/02212012-duration-and-convexity.aspx#comments<p>In a few recent columns, we&rsquo;ve talked about <a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02062012-relative-performance-duration.aspx">duration</a> and <a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02122012-mbs-market-technicals.aspx">convexity</a> in the context of changing market prices.&nbsp; They are some of the most misunderstood and misused terms in finance, and clarifying them is probably worth a few column inches.&nbsp; I won&rsquo;t focus here on how to calculate the measures, but rather helping readers understand what they tell us about a bond&rsquo;s expected price performance.<br /><br />As I described last week, portfolio managers holding MBS need to undertake <b>convexity buying and selling</b> as interest rate levels change; the duration of their portfolio is changing with rates, although the changes are the opposite of what a portfolio manager would normally do as rates move.&nbsp; In a bond market rally, a rational PM would look to extend his/her duration in order to get the maximum benefit from rising bond prices; in a selloff, the PM would shorten the portfolio&rsquo;s duration in order to minimize his/her exposure to declining bond prices.&nbsp; Because of prepayments, however, the opposite is happening.&nbsp;&nbsp; Rising rates imply lower levels of prepayments and longer MBS durations, meaning that without adjustments the portfolio&rsquo;s value would become more sensitive to changing rates.&nbsp; A decline in interest rates, alternatively, means that prepayments are increasing, shortening the duration of MBS and forcing PMs to buy bonds in the face of higher prices.<br /><br />Let&rsquo;s take a more technical look at these two measures.&nbsp; Duration is the sensitivity of a bond&rsquo;s price to changes in its interest rate or, more precisely, the yield to which it is being valued.&nbsp; The easiest way to envision a bond&rsquo;s duration is as a downward-sloping line where the horizontal axis shows the bond&rsquo;s yield and the vertical axis its price.&nbsp; As the yield rises, the bond&rsquo;s price declines, and vice versa.&nbsp; If charted, the duration is approximately a straight line; this is the case when the bond being evaluated does not have any type of option attached to it.<br /><br />Convexity is a second-order measure of a bond&rsquo;s expected price performance.&nbsp; The chart below shows the durations of two different bonds.&nbsp; One is a fixed-cash-flow bond (such as a Treasury note or non-callable corporate debenture), and the other is a mortgage-backed security, where the bondholder is short a series of options (due to the borrowers&rsquo; option to refinance their mortgages).&nbsp;&nbsp; Note that the line is curved for the MBS.&nbsp; The degree of curvature of a duration function is its convexity; since MBS are negatively convex, the line is lower than the straight line at higher and/or lower rate levels, i.e., the &ldquo;wings.&rdquo;&nbsp;&nbsp;&nbsp; (This relationship occurs because of changing prepayment expectations for the MBS.&nbsp;&nbsp;&nbsp; Note that if you owned a &ldquo;put-able&rdquo; bond, its price performance would exceed the straight line as rates, and the bond would be considered positively convex.)<br /><br />The <b>key implication</b> is that a bond&rsquo;s duration changes, to different degrees, as rates change.&nbsp; Convexity describes how much the value of a bond (or a bond portfolio) will deviate from the roughly straight line represented by its duration.&nbsp;&nbsp;&nbsp; A good way to get a handle on the concepts is to compare them to examples in the physical world.&nbsp; Duration is the equivalent of speed, which is a first-order measure of movement&mdash;it is measured in miles per hour, feet per second, etc.&nbsp; Convexity is the equivalent of acceleration; it is measured in feet per second per second, and is the rate of change of the rate of change.<br /><br />A <b>fun example</b> is to pretend to be a judge in traffic court.&nbsp; Imagine that you have two cases being argued before you (bad drivers need to hire lawyers) where the drivers got speeding tickets for being timed at 60 MPH in a 55 MPH zone.&nbsp; If you&rsquo;re inclined to give drivers a 5 mph &ldquo;fudge factor,&rdquo; do you have enough information to decide these cases?<br /><br />The answer is that you don&rsquo;t have enough information.&nbsp; In this example, one car was traveling at a constant 60 MPH, and never drove faster than 5 MPH above the speed limit.&nbsp; The other began from a standing stop, and was going over 100 MPH when it passed the policeman.&nbsp; Since &ldquo;speed&rdquo; is calculated as a function of time (remember from high school that Rate =Distance/Time), being told that the drivers were traveling at 60 MPH doesn&rsquo;t tell you much about their actual behavior.&nbsp; Like speed, duration is a useful but incomplete measure for describing a complex phenomenon.<br /><br />The other thing to note is taking duration and convexity into account still does not entirely explain a bond&rsquo;s price performance.&nbsp; Both duration and convexity are calculated using fairly rigid assumptions&mdash;unchanged spreads, no changes in the shape of the yield curve, etc.&nbsp; Therefore, even the inclusion of convexity in the conversation does not account for all the reasons that a bond&rsquo;s price changes and out- or underperforms a benchmark.&nbsp; A common mistake is to observe a bond underperforming its hedge ratio in a rally and assume that it underperformed because of &ldquo;negative convexity.&rdquo;&nbsp; In reality, the underwhelming relative performance may be due to spread widening rather than convexity.&nbsp;&nbsp;&nbsp; There&rsquo;s a simple way to view this difference:&nbsp; Price changes due to duration and convexity mean that you&rsquo;re moving up and down the price line shown above; spread widening means that the line itself is shifting up or down.&nbsp; That&rsquo;s why models have so-called attribution functions that will analyze data from two different dates and tell the user how much of the price change is attributable to different factors such as duration, convexity, spread, etc.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02212012-duration-and-convexity.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/248246/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=248246" width="1" height="1">convexityaccelerationDurationspreadMBS Market Technical Factors: Convexityhttp://www.mortgagenewsdaily.com/channels/secondary_markets/02122012-mbs-market-technicals.aspxWed, 15 Feb 2012 21:16:39 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:247171Bill Berliner0http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=247171http://www.mortgagenewsdaily.com/channels/secondary_markets/02122012-mbs-market-technicals.aspx#comments<p>A lot of analysis that gets written will refer to <b>"technical factors"</b>
driving valuations. &nbsp;What this is referring to are situations where
unique factors are impacting valuations. &nbsp;The classic business school
example that comes to mind is the unique case of "flower bonds." &nbsp;These
were special issues of low-coupon U.S. Treasuries that could be used to
pay Federal estate taxes at par value; as a result, they traded at
extremely low yields. &nbsp;The unique nature of the mortgage and <a href="../../../mbs/">MBS markets</a>
means that there are a number of situations that affect market levels,
and understanding them can help lenders and secondary market managers do
a better job of managing and hedging their pipelines.</p>
<p>An MBS-specific example of technical factors is so-called <b>"convexity" buying and selling</b>.
&nbsp;This refers to the fact that large bond market rallies and selloffs
tend to be self-perpetuating; big market moves often push yields beyond
levels that can be explained by changing economic expectations. Readers
of the MBS Commentary channel will have encountered this phenomenon as
"snowball" selling or buying.&nbsp;</p>
<p>To understand this, we first need to review several market fundamentals. &nbsp;Remember that the MBS market is huge, <b>second only in size to the Treasury market</b>.
&nbsp;Roughly $5.5 trillion in MBS issued under the auspices of Fannie Mae,
Freddie Mac, and Ginnie Mae are outstanding. &nbsp;(The MBS market used to be
larger than the Treasury market, but a few years of trillion-dollar
deficits changed that dynamic.) &nbsp;</p>
<p>In addition, mortgages are <b>prepayable </b>at the option of the homeowners. &nbsp;Any investor or portfolio manager holding <a href="../../../mbs/">MBS or mortgage-related securities</a>
has to make some judgment on how rapidly their holdings will prepay.
&nbsp;(That's why prepayment metrics are referred to as "speeds.") &nbsp;When
interest rates decline, investors will assume faster prepayment speeds
for their holdings, which means that their portfolios are effectively
getting "shorter" in both average life and price sensitivity to rate
moves, i.e., duration. &nbsp;If rates rise, the opposite happens; investors
assume slower prepayments, which in turn extend the average lives and
durations of their holdings.</p>
<p>This means that investors both large and small need
to adjust the duration profile of their portfolio when interest rates
change, especially if they are "index" investors that track the duration
of major market indices. &nbsp;Since rate declines (i.e., rising bond
prices) are associated with shortening durations, investors need to buy
assets in order to maintain their portfolio's duration, perpetuating the
rally. &nbsp;Alternatively, rising rates are associated with the selling of
duration (either MBS or any fixed-income asset with positive duration)
by investors, pushing bond prices still lower. &nbsp;</p>
<p>These activities tend to push market moves beyond
what would be associated with simple changes in expectations, and are
referred to as "convexity buying" or "convexity selling" because they
result from the negatively-convex nature of MBS. &nbsp;(I'll discuss
convexity in a future post.) &nbsp;Understanding this phenomenon can help
investors gauge the intensity and duration of market moves, and adjust
their responses accordingly. &nbsp;(Note that the fact that the Federal
Reserve holds over $1 trillion of agency MBS has dampened this response a
bit; the Fed is a "passive" investor and does not adjust its holdings
to changing rate levels.)</p>
<p><b>Next Time:&nbsp; Technical Factors Part 2: Dollar Rolls</b></p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02122012-mbs-market-technicals.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/247171/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=247171" width="1" height="1">dollar rollsconvexity tradingTechnical factorsThe Hidden Mortgage Tax and it's Effect on Loan Pricinghttp://www.mortgagenewsdaily.com/channels/secondary_markets/02092012-g-fee-add-on.aspxFri, 10 Feb 2012 19:21:46 GMT2bb7a989-b681-446d-a7f2-bd5f0562f228:246992Bill Berliner1http://www.mortgagenewsdaily.com/channels/secondary_markets/rsscomments.aspx?PostID=246992http://www.mortgagenewsdaily.com/channels/secondary_markets/02092012-g-fee-add-on.aspx#comments<p><!--[if gte mso 9]><xml>
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</p>
<p class="MsoNormal">The latest hot issue in the mortgage markets has been the <b>10
basis point addition to G-fees</b> mandated by the payroll tax cut passed late last
year.<span>&nbsp; </span>Unfortunately, the media has only
recently picked up on the fact that this &ldquo;tax cut&rdquo; was financed by a <b>hidden tax
on mortgages</b>.<span>&nbsp; </span>However, since neither
Congress nor the President know much about mortgages, details on how this tax
would be imposed were not included in the bill.<span>&nbsp;
</span>The legislation did not state, for example, whether the 10 basis point
g-fee surcharge was considered part of the guaranty fee or a separate add-on to
the loan&rsquo;s rate.<span>&nbsp; </span></p>
<p class="MsoNormal">Read: <a href="/01042012_bb_t_announces_g_fee_hike.asp">Tax Cut Extension Now Officially Raising Mortgage Rates</a></p>
<p class="MsoNormal">This <b>ambiguity </b>created a number of issues for lenders.<span>&nbsp; </span>Most servicing contracts specify that the
total amount of interest either bought up or down with the GSEs cannot exceed a
fixed sum, i.e., 37.5 basis points (which is fairly standard language).<span>&nbsp; </span>If the total g-fee (including the surcharge)
is increased by 10 basis points, the amount of excess servicing that can be
&ldquo;bought up&rdquo; is thus reduced by the same 10 bps.<span>&nbsp;
</span>While buy-ups used to be relatively rare (since Freddie and Fannie both
assign putrid multiples to the cash flow), the lack of ready buyers for
servicing means that another avenue for selling excess servicing has been
rendered uneconomical.</p>
<p class="MsoNormal">The additional fee also has played havoc with <a href="/mortgage_rates/">loan
pricing</a>.<span>&nbsp; </span>As I understand it, the GSEs&rsquo;g-fee
buy-down multiple (i.e., what they will charge to convert the g-fee into a
single payment paid when the loan is pooled) is around 6x.<span>&nbsp; </span>This means that the 10 bp surcharge is worth
around 60 basis points in price (or 0.6% of a loan&rsquo;s face value).<span>&nbsp; </span>The uncertainty surrounding the surcharge also
threatened to disrupt pooling practices.<span>&nbsp;
</span>To this point, there has been no guidance on whether the entire g-fee
(including the surcharge) actually can be bought down.<span>&nbsp; </span>If it couldn&rsquo;t, that would mean that <b>30-year
3.75% loans could not be securitized into agency 3.5% pools</b>, the lowest coupon
with good liquidity and well-behaved pricing.<span>&nbsp;
</span>If these loans can only be pooled into Fannie or Gold 3s, this could
severely disrupt both the <a href="/mbs/">MBS market</a> and loan pricing.<span>&nbsp; </span>(As I discuss later, heavy originator selling
will in turn increase the points required for lenders to offer these loans&mdash;or,
more simply, make it more expensive for borrowers to obtain low rates.)</p>
<p class="MsoNormal">I&rsquo;ve been told that both Freddie and Fannie will have a call
today (Friday, 2/10) to clarify the treatment of the surcharge.<span>&nbsp; </span>As I understand it, the surcharge will be
treated as part of the g-fee, meaning that it can be bought down entirely.<span>&nbsp; </span>This will allow 3.75% loans to be pooled in
3.5% pools; while it will be relatively expensive to buy down the entire g-fee,
it does give lenders the option of either pooling down (into 3s) and holding/selling
the servicing, or pooling into 3.5s by buying down the g-fee.</p>
<p class="MsoNormal">This in turn raises the interesting and important issue of
<b>how the lower coupons are trading</b>.<span>&nbsp; </span>There
is decent liquidity in 15yr 2.5s, with average monthly issuance of 585mm over
the last three months.<span>&nbsp; </span>However, the
market for 30-year conventional 3s remains relatively illiquid, although
production seems to be ramping up; according to Fannie Mae, roughly 230mm 3%
pools have been created thus far in February.<span>&nbsp;
</span>While the overall price performance of Fannie 3s is better than it has
been in the past (when prices could move up or down by a half-point or more on
minimal volume), the dollar rolls remain pretty volatile.<span>&nbsp; </span>A decent origination day will push prices in
the back months (April and May) sharply lower, while front months (February and
March) remain roughly in line with other coupons, duration-adjusted.<span>&nbsp; </span>This week, for example, saw the March/April
roll (i.e., the price difference between March and April) for Fannie 3s as wide
as 30/32s (equal to a financing rate of -7%); the roll is now 21/64s (for a
more moderate -0.71%).</p>
<p class="MsoNormal">There is a <b>complex interactive relationship</b> between a
security&rsquo;s price performance and issuance.<span>&nbsp;
</span>A coupon won&rsquo;t perform well if its outstanding balance remains small; a
small tradeable &ldquo;float&rdquo; means that prices can get pushed around on very limited
volume.<span>&nbsp; </span>However, no originators will
issue pools for securities with erratic performance.<span>&nbsp; </span>The biggest factor inhibiting the growth of
the market for 30-year 3s is the belief that there is no natural clientele for
the security.<span>&nbsp; </span>Its coupon is too low, and
its duration too long, for banks and depositories; insurance companies and
pension funds that would buy their long average lives and durations need higher
returns on their portfolios.<span>&nbsp; </span>In my mind,
the only natural holder is the government (or, more to the point, the
Fed).<span>&nbsp; </span>A program to purchase 30-year 3s
(and 15-year 2.5s, to a lesser extent) would be the most direct way for the government
to positively influence the mortgage markets.</p>...(<a href="http://www.mortgagenewsdaily.com/channels/secondary_markets/02092012-g-fee-add-on.aspx">read more</a>)<p><div style="background-color:#D4EDC9;border:1px solid #BDD4B3;padding:3px 5px 3px 6px; color:#000000;font-family:arial,sans-serif;font-size:12px;"><strong>Forward this article via email:</strong>&nbsp;&nbsp;<a href="http://www.mortgagenewsdaily.com/channels/246992/3/forward.aspx" style="color:#3333CC;">Send a copy of this story</a> to someone you know that may want to read it.</div></p><img src="http://www.mortgagenewsdaily.com/aggbug.aspx?PostID=246992" width="1" height="1">mortgage taxG-feemultiple